A Second Chance for the TPP

Jan 9 2019

By Phillip Orchard – Geopolitical Futures

The new trade agreement has the same goals as its predecessor – but it’s missing one key member

The Trans-Pacific Partnership may have life in it yet. On his first day in office, nearly two years ago, U.S. President Donald Trump withdrew from the TPP, effectively leaving the landmark trade pact for dead. As it turns out, the agreement was only mostly dead. On Dec. 30, the clumsily rechristened Comprehensive and Progressive Agreement for Trans-Pacific Partnership came into force. The pact removes some 98 percent of tariffs across an 11-member bloc that accounts for more than one-tenth of global trade and includes critical supply chain and investment hubs on three continents.

Its revival is a remarkable diplomatic feat – undercutting narratives of the impending doom of global free trade. And it illustrates the sense of urgency Pacific Rim countries are feeling to manage the disruptions accompanying China’s rise, with or without the United States. Thus, the pact is about more than expanding trade among member states; it’s also about countering growing threats to the existing order that fueled the region’s rise.

The U.S.-led push for the original 12-member pact and the Japan- and Australia-led revival were both motivated by two overriding objectives: to modernize the global trade architecture and to prevent China from successfully operating outside of that framework. Ultimately, though, its success will still depend on whether the U.S. can be coaxed back into the fold.

The Imperative for Reform

For the last 70 years, the global economy has been driven by what is described as an open, rules-based trade framework. The U.S. championed open trade – throwing its weight behind agreements like the General Agreement on Tariffs and Trade in 1948 and its successor, the World Trade Organization. These frameworks helped bring an end to the tit-for-tat trade escalations that had contributed to economic chaos in the first half of the 20th century. They also allowed the U.S. to export surplus industrial capacity it had built up during World War II, cement U.S. primacy and build an alliance structure whose prosperity stood in stark contrast to communist systems. The doors to accession were thrown wide open to allied economies, and the U.S. asked little in return, hoping merely that unlocking growth in war-ravaged states would restore stability and diminish the need for direct U.S. intervention.

The trade infrastructure designed by the U.S. has, by many measures, been a resounding strategic and economic success. Since 1948, tariffs have dropped by 80 percent worldwide and trade has doubled as a share of the global economy. The Soviet bloc crumbled, unable to keep up with Western dynamism and the resulting growth in military capacity. The system helped “Asian Tigers” like Japan, South Korea and Taiwan recover from mid-century wars and emerge as high-tech export powerhouses. And it positioned Pacific Rim countries from Singapore and Malaysia to Mexico to play critical roles in global supply chains emanating from Asia.

But the system has increasingly struggled to keep up with its success and is desperately in need of updating. The rapid industrialization of low-cost exporters distorted markets and accelerated the loss of labor-intensive manufacturing jobs in advanced economies. Simultaneously, efforts to update infrastructure to handle modern sectors where advanced economies had comparative advantages – including investment, services, high-tech manufacturing and the digital economy – have repeatedly stalled. Whatever the long-term benefits of free trade, short-term disruptions inevitably erode political support for open systems. The widespread Western perception that low-cost exporters have been enjoying market access unlocked by the global system without complying with its rules – even stymieing much-needed updates – has made free trade synonymous with unfair trade.

These strains on the system are felt most acutely in the stagnation of the WTO. The body’s rules have not been substantively updated in nearly 25 years, and reaching an agreement to reform an organization with 164 members would be a herculean feat. The reform priorities of developed nations don’t necessarily align with the interests of developing economies. A number of emerging heavyweights like India have contributed to the gridlock. And even the U.S. is blocking appointments of new appellate judges and threatening to ignore WTO rulings altogether – which would completely defang the increasingly toothless body. But China’s exponential growth since it joined the group in 2001, along with its apparent unwillingness to end its mercantilist trade practices, has done the most to expose how outdated and ineffective the WTO has become.

China: Kept at Bay, or in the Fold?

For Western and Pacific Rim countries, the priority has not been to blunt China’s rise, but rather to convince Beijing to play by a shared set of rules. Severing ties with China would be profoundly disruptive and laden with opportunity costs, given the extraordinary growth of the Chinese consumer market. Low-cost Chinese exports, meanwhile, have suppressed inflation in advanced economies and mitigated the pain of wage stagnation that has resulted from the loss of labor-intensive manufacturing jobs. While China is partly to blame for those losses, automation and the rise of other low-cost manufacturers mean those jobs aren’t coming back en masse. Thus, advanced economies need access to Chinese consumers, exports and investment – but they also need to protect themselves from Chinese trade practices that threaten to hobble their own firms. The WTO was designed to deal with this very dilemma – but it’s no longer up to the task.

What else can be done? One approach is to bring China to heel through unilateral pressure. The Trump administration’s tariffs are the latest and most aggressive example of this approach, but there are limits to this strategy. The size of China’s consumer market is giving it the ability to punch back with greater force. It’s also making it hard for the U.S. to build that which Beijing fears most – a united front against China. As U.S. firms cede ground in the Chinese market due to Beijing’s retaliatory tariffs, it opens opportunities to firms from other countries, incentivizing them to stay out of the trade war. (A month after the September round of U.S. tariffs kicked in, for example, Japanese exports to China increased 9 percent year on year.)

Another approach is to build out multilateral trade infrastructure around pacts like CPTPP, effectively forcing China to choose between isolation and compliance. Such agreements can function like a WTO premium: Benefits like expanded market access can be offered in return for compliance with an updated set of rules. The pact contains guidelines on investment, intellectual property, labor and environmental protections, and the role of state-owned enterprises – features advanced economies would like to incorporate in updated WTO rules. Fear of missing out on CPTPP’s perks has proved to be a powerful motivator for reform among member states – and a useful tool for governments grappling with entrenched interests over certain reform measures. (Japan, for example, has used the lure of the agreement to take on its agricultural lobby. Malaysia and Vietnam are using it to dismantle state-owned enterprises.)

Practically, however, the Communist Party of China cannot adopt liberal economic reforms as quickly and comprehensively as the West would like without risking its hold on power. Beijing will chip away at the edges of liberalization to better tap into its latent dynamism and keep Western markets open to Chinese exports. But if forced to choose between opening up and retaining its hold on power, the CPC will always choose the latter. Moreover, China has a fundamental strategic interest in tilting the military balance of power in the Indo-Pacific. It can’t yet uproot the U.S. alliance structure by force, so Beijing’s best bet is to deepen its economic influence in neighboring countries sufficiently to turn them against the U.S. and its allies. This requires an intense campaign of economic statecraft, including tools like state-owned enterprises and banks and industrial subsidies – which the West blames for distorting markets.

Tariffs won’t change any of this; threats of isolation may not, either. Rather, they’re just as likely to persuade Beijing to double down on its efforts to carve out a discrete sphere of influence where it can set the rules. China’s growing economic clout abroad is already aiding such efforts. So too is China’s accompanying growth in military firepower.

Naturally, countries with the most to lose from a disruption to the established order – like Japan, Australia and Singapore – are laying the groundwork for a robust containment strategy, with or without the U.S. CPTPP is a major part of this: It will reduce the risk of overdependence on China among weaker members like Vietnam, cement Japan as a regional counterweight to China and take the air out of Beijing’s attempts to dominate negotiations over alternative trade pacts like the Regional Comprehensive Economic Partnership. The goal of CPTPP’s champions is to prevent China from gaining enough power to dictate those neighbors’ terms of engagement with the U.S. and its allies.